Is It Unfair Competition to Sell a Product in the U.S. that was Manufactured Overseas Using Pirated Software?

September 27, 2012

Guest Post

By Eric Priest, Assistant Professor, University of Oregon School of Law

China’s pervasive intellectual property piracy problem, and the resulting impact on American industry and jobs, is a constant refrain in U.S. media and even the presidential campaign. But are some U.S. companies also benefitting from the infringement? Some policy makers and software companies are beginning to ask whether U.S. businesses are actually indirect beneficiaries of pirated intellectual property in China (and elsewhere). When an upstream producer such as a Chinese factory uses pirated software in its manufacturing or logistics operations, the cost of production is reduced. Some of those savings can also be passed along to the U.S.-based firm that hired the factory, or to the retailer that sells the product. These cost savings arguably give the overseas manufacturer and the seller of such a product in the U.S. an unfair edge over competitors in the U.S. market.

Louisiana and Washington State passed laws in 2010 and 2011, respectively, that make it an act of unfair competition to sell a product manufactured using “stolen or misappropriated” information technology. The Louisiana statute is terse and therefore broad, while the Washington statute contains detailed limitations on liability and requires that the defendant be given notice and have the opportunity to cure. The Washington statute creates liability for the manufacturer as well as for certain third parties (i.e., sellers other than the manufacturer), although it limits potential third-party liability to large companies with over $50 million in annual revenue, which are better positioned to police suppliers.

In addition, Attorneys General from thirty-six states and three U.S. territories last November requested that the FTC consider using its broad unfair competition authority under § 5 of the FTC Act to pursue manufacturers who sell in the U.S. goods that they produced using pirated software in competition with law-abiding manufacturers. In addition to such federal action, some state Attorneys General have indicated they would consider the possibility of using existing state unfair competition laws (the “mini-FTC Acts”) to the same effect.

Professor Andrew Popper of American University’s Washington College of Law recently authored an informative and well-researched Issue Brief for ACS, “Beneficiaries of Misconduct: A Direct Approach to IT Theft,” advocating U.S. legal remedies targeting the domestic effects of IT theft in overseas upstream supply chains. He argues that addressing these harms under state and federal unfair competition laws is an attractive option because although the act of software copyright infringement often occurs in foreign countries and beyond the reach of the U.S. Copyright Act, the manufacturer and U.S. seller nevertheless benefit in the U.S. market at the expense of their competition.

It is difficult to evaluate the merits of the unfair competition argument without more facts about the effect of overseas IT theft on U.S. markets. It is hard to know, and Professor Popper does not quantify, what real cost advantages a U.S. business enjoys when it sells a product that was made by a company that utilized pirated software in its operations. The Attorneys General cite specific examples of IT theft in their letter (an Indian apparel manufacturer that uses over $14 million in unlicensed software; a Mexican paper manufacturer that uses over $10 million in unlicensed software; a Chinese parts manufacturer that uses $5.2 million in unlicensed software), but also do not quantify the actual harm to U.S. competitors. If a commercial advantage can be demonstrated, however, it certainly seems unfair to have obtained it by violating the law.

That argument is murkier in the indirect liability context such as that created in the Washington statute, where an overseas contract manufacturer commits copyright infringement and the U.S.-based seller could face unfair competition liability. But therein lies the crux of the matter. While this unfair competition theory does encompass direct liability (that is, a foreign manufacturer could be held liable in the U.S. for the unfair commercial advantage arising from its overseas infringement), its potential for greatest impact may be in the possibility of creating indirect liability, as provided for in the Washington statute.

Why? Because in China, where copyright law is notoriously difficult to enforce and even successful lawsuits typically result in pitifully low damage awards, the remote possibility of being haled into court by a U.S. copyright owner hardly motivates manufacturers to purchase thousands or millions of dollars in software licenses. Likewise, for many Chinese manufacturers the threat of unfair competition liability in the U.S. is small deterrent due to insufficient U.S. contacts or assets. But any manufacturer will surely listen when its U.S. customers say, “I need you to clean up your act or I will take my business elsewhere.”

The unfair competition approach raises concerns, to be sure, including the extent to which its extraterritorial effects violate norms of state sovereignty and territoriality of rights in intellectual property law, as well as federal preemption issues for state causes of action (although the Washington statute goes to considerable lengths to address preemption concerns). It is also worth asking if, in the case of third party liability, it is fair to hold U.S. companies liable for the infringements of their foreign suppliers. While this is a complex issue, theories of indirect or “gatekeeper” liability teach that there are sound policy reasons to sometimes target legal sanctions at the entity most likely to bring about the desired result, and that entity is not always the direct infringer. If suing the direct infringer is impracticable, the better positioned a third party is to prevent the infringement, and the more benefit it derives from the infringement, the more compelling the argument to hold that entity liable. Statutory safeguards like the Washington statute’s notice and cure provisions also help address fairness concerns.

These very real concerns notwithstanding, indirect liability under the unfair competition approach is intriguing. Market-based pressures have been shown to achieve far more effective copyright enforcement in China than traditional means (lawsuits, administrative enforcement, and lobbying the USTR to pressure Chinese authorities to crack down on infringers). These traditional routes have proved relatively futile for various reasons, but in one success story, internet video streaming sites (i.e., Chinese YouTube clones) that were once havens for infringing content now spend tens of millions of dollars on film and TV copyright licenses and purge their sites of infringing content. Why? It isn’t because the sites themselves particularly fear copyright infringement liability. Rather, they fear losing large transnational advertisers (e.g., Coca-Cola) that the websites worried were increasingly uncomfortable with being associated with piracy and that have even been sued (unsuccessfully) in China as copyright infringers for advertising on video websites containing pirated content.

Moreover, while no cases have been brought under the Washington or Louisiana statutes, the bare possibility of indirect liability provides an incentive for industry groups to address the problem of overseas piracy by developing private standards or best practices concerning intellectual property compliance by overseas subsidiaries and manufacturers. That approach has been effective in the environmental law context, for example, in which multinational companies, responding to pressure from customers and NGOs, have established voluntary environmental standards that they enforce though contracts with foreign suppliers. Such “private governance” can be far more effective than public regulation and enforcement, particularly in countries where regulations are inadequate or enforcement ineffective. Getting the diverse interests that span the copyright and technology industries to reach agreement on this issue is doubtless a major challenge. Still, the payoff is the prospect of cultivating greater overall respect for intellectual property rights in markets such as China. That should be something that all copyright and technology industry stakeholders, and the U.S. business community, can get behind.